How To Understand Why Apple’s Stock Dipped 4.3%

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Shares in Apple Inc. sold off on Wednesday following the company’s June quarter earnings report on Tuesday. AAPL ended the day at US$574.97, down $25.95 (-4.32 percent) on volume of 31.3 million shares trading, more than triple the average volume. I’m going to explain why it happened.

The stock opened at $570, and then traded in a fairly narrow band throughout the day, as shown in the chart below. Investors were punishing the stock for a miss on both gross margins and earnings per share ($9.32 EPS reported vs. consensus of $10.35). In addition, Apple offered much lower than expected guidance for the September quarter, especially for gross margins.

AAPL Chart for July 25th, 2012

AAPL Chart for July 25th
Source: Yahoo! Finance

Allow me to be blunt: Apple fans who don’t understand the markets are confused by Apple’s selloff, and many of them have worked themselves into self-righteous indignation on Apple’s behalf. After all, a surface examination of Apple’s results doesn’t show a miss, it shows a record June quarter, record iPad sales (17 million units), and record Mac sales for the June quarter (4 million units). In addition, Apple beat its own guidance for the quarter, leading readers to question our coverage of these results as a miss.

That’s not the way the stock market works, however; Apple’s stock price and overall valuation is based not on this quarter’s results or last quarter’s results, but rather on future results. Investors are constantly looking ahead at how they expect a company to perform over the next 3-24 months, depending on the company, and sometimes even further out.

While all that is going on, Wall Street looks to get information from wherever it can. Apple’s notorious secrecy is not limited to its product plans, as the company doesn’t divulge many specifics of its financial performance. Sales numbers aren’t broken down by device, for instance, but are limited to product categories. More recently, Apple CEO Tim Cook suggested that Apple will try to keep secret any companies it buys where it can legally do so.

Analysts and investors, including hedge fund managers, try to learn what they can from Apple’s supply chain, traffic at Apple’s retail stores, earnings reports from any company that has anything to do with Apple’s supply chain, and even from illegally bribing people to sell information on what Apple is ordering.

Thrown into the mix is Apple’s own guidance, which is usually limited to the next quarter’s performance. As noted above, Apple beat its own guidance for the June quarter, but Apple has been sandbagging its guidance for the past 12 years or so. As Sterne Agee analyst Shaw Wu recently put it, Apple offers “vintage conservative guidance.”

When you do that quarter after quarter, year after year, it becomes more of an inside joke than practical guidance, and I’ve personally heard Wall Street professionals laugh about it. Over the years, the game has evolved to predict not whether or not Apple would beat its guidance, but rather by how much Apple will crush its own guidance.

This is a game engaged in by Wall Street analysts and investors, and the members of our own Apple Finance Board have become some of the best prognosticators around.

Accordingly, looking at the June quarter results and saying, “But Apple beat its own guidance” is less than half the picture.

If you’re still thinking, “So what! Apple had a kick ass quarter and that’s all that matters!” read on.

As noted above, Wall Street looks forward at Apple’s future performance when deciding how much the company is worth. By definition, that means that Apple’s stock has already been rewarded or punished ahead of time for what Wall Street has predicted the company will do.

If Wall Street expects Apple to do X, but Apple does 1.1X—in very rough terms, Apple has routinely turned in results closer to 1.3X—the stock will jump because Wall Street hadn’t already valued that .1X performance.

If, on the other hand, Apple turns in results of .96X, Wall Street will punish the stock by taking that .04X valuation off the table. That’s what happened on Tuesday, when the stock closed 4.3 percent lower.

To put this more succinctly, Apple’s stock value is not based on Apple’s guidance, it’s based on Wall Street’s predictions and expectations. Beating its own guidance and turning in a record quarter doesn’t matter that much when Wall Street has already boosted the stock to a price that supports its own predictions.

In a research note to clients on Wednesday, Sterne Agee’s Shaw Wu told his clients, “While light revenue and a potential iPhone unit shortfall were somewhat anticipated ahead of a refresh, EPS and gross margin misses weren’t.”

There’s one more factor, however: Apple’s guidance for the September quarter was also well below what Wall Street had expected, especially for gross margins. Apple guided for gross margins of 38.5 percent, more than 400 basis points lower than many analysts were modeling.

Again, Apple is sandbagging, but the company’s guidance is well below what was expected, and Apple’s stock price had already been priced to include the higher expectations. All that happened today is the process of adjusting to the new expectations.

At the end of the day, Wall Street is very efficient, so efficient that small players (i.e. retail investors) are at a significant disadvantage. Not every analyst understands Apple’s business model and value proposition, but many do. It’s been slow in coming, but Apple’s amazing performance over the last 10-12 years has shown the world that the company is doing something right.

The Street as a whole is a very rational entity, and there is some very, very smart money (i.e. the hedge funds) that are doing everything it can to extract every penny of value out of the market, including Apple.

My personal recommendation is that when you see AAPL movement that doesn’t make sense, rather than assuming that Wall Street doesn’t know what it’s doing, start from the vantage point that maybe someone else knows more than you and work backwards from there. More often than not, there is sound reasoning behind big movements in Apple’s stock, even if it’s macro-economic concerns that aren’t directly related to Apple’s business.

*In the interest of full disclosure, the author holds a tiny, almost insignificant share in AAPL stock that was not an influence in the creation of this article.

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Comments

Lee Dronick

Buy

jfbiii

First, my own criticism of calling Apple’s results a “miss” wasn’t aimed at TMO in particular. It was just a reflection on the fact that actual results are called a miss because they don’t measure up to guesses. It’s a lack of precision with the language that I have an issue with. When you make a guess as to the outcome of a sports game and your guess is wrong, then your prediction was wrong; the outcome of the game is what it was. I understand why it happens, in large part: investors try to game the system and analysts, loath to be wrong, argue that they were right and the company didn’t live up to what it could have. The game is what it is. It doesn’t change the abuse of language, which itself is deliberate and just one more manipulation technique.

Second, I don’t believe that your explanation of future valuation matches up to the historical reality of Apple stock manipulation centered on quarterly reporting.

The Street as a whole is a very rational entity

It plays by its own rules, to be sure. But its valuation of companies is largely irrational, in that it its fluctuation is not pegged to objective values.

daemon

The Street as a whole is a very rational entity, and there is some very, very smart money

Bryan, I disagree. I think the Street is very irrational and often goes on long spending sprees based on feel good stories.

It happened in the dotcom bubble and the mortgage bubble and a multitude of other bubbles that I barely am aware of. Apple, is not a bubble, it’s a real business, if it’s share price dropped to pennies it would still be here making amazing products, despite so many investors being wiped out. But I still think the share price has vastly outgrown the real value of the company. It’s almost like they expect the earnings per share to become a dividend….

Bryan Chaffin

Daemon, I think that’s a great point. The markets definitely have spikes of irrationality and I thank you for that dose of reality.

In the long run, however, rational thought prevails. Your thoughts?

daemon

In the long run, however, rational thought prevails. Your thoughts?

Prognosticators are doomed to always be remembered for what they got wrong…

I think the irrational motives get rational explainations that help people feel better about their investing strategies. The rational investor likely understands this and does his best to exploit it.

wab95

My personal recommendation is that when you see AAPL movement that doesn?t make sense, rather than assuming that Wall Street doesn?t know what it?s doing, start from the vantage point that maybe someone else knows more than you and work backwards from there. More often than not, there is sound reasoning behind big movements in Apple?s stock, even if it?s macro-economic concerns that aren?t directly related to Apple?s business.

Very nicely summarised, Bryan.

I also think that daemon makes an excellent point about expectations.

I just want to underscore your closing comments, which are a sobering reminder that, in every profession, Wall Street being no exception, the standards employed by professionals will often diverge from the popular wisdom prevalent in the lay public, but they are no less rational for it.

While Apple’s projected performance is based on estimates, it would wrong to dismiss those estimates as guesswork on par with a layman’s, and is (almost) equivalent with comparing a tested and testable scientific theory with an opinion. Both encompass uncertainty, but a theory’s uncertainty is quantifiable and data-justified, lending it a consistent level of predictive power; whereas the uncertainty inherent in an untested opinion is neither quantifiable nor data justified, rendering its predictive power meaningless. The estimates used by the Street are data-driven and mathematically derived, and therefore provide a measure of structured guidance.

What complicates that guidance is the human factor, which comes back to daemon’s point. This is where, in my view, irrational expectation (bullish or bearish) on the part of a sizeable fraction of investors can play havoc on the market, derail the models, and cause the rest of us to dismiss those previous projections as wild guesses.

Your post-mortem on the after-effects of Apple’s quarterly report on its stock valuation is consistent at least with discussions I have had with some very smart professionals on Wall Street.

Tiger

I’m with Lee. Buy. Great time. Stock may still top over $700 within a year’s time. iPhone 5 is going to be big. And it’s only 2+ months away.

llg4nlp

Great commentary, Bryan.  You are one of the very few in the Mac community, that understands the market.  That said, I do have one small quibble - I do think AAPL is currently undervalued, based on P/E - it’s really low, for a company that is growing at the rate of AAPL. 

That said, to the degree that macroeconomic issues caused the miss, perhaps I am mistaken on this.

For those who want another interesting, informed ‘take’ on Apple’s quarterly results, I recommend the latest episode of ‘The Critical Path’ podcast.

Bosco (Brad Hutchings)

The basic problem with Apple is lack of fragmentation. It’s easy to blame iPhone sales drop-off on product cycles or fanboys or rumours, but the fact is that the iPhone 4/4s form factor is much less popular today than it might have been 2 years ago. It’s like trying to sell Priuses to a market that now wants SUVs.

The fragmentation that Apple enthusiasts mock is what lets the Android market learn and individuals to find the right phone for them. By embracing fragmentation, the Android handset makers and developers internalize flexibility from the beginning. Meanwhile on the Apple side of things, the “avoid fragmentation” by pixel doubling. So even if there were form factor differences, you wouldn’t get any real benefit of additional screen real estate.

When I put my iPhone in the drawer 2+ years ago, the reason for giving Android a shot was Steve’s utter insanity and incivility. The reason for sticking with Android was the platform richness that was so apparent to me then, and which I hoped would eventually dominate because it deserved to dominate. It’s hard to not feel pretty vindicated with Apple’s results this quarter and the very fundamental problems with the Apple approach that have let Sammie just pass them by in handsets.

And BTW, this “you copy us” crap may make you all feel superior now, but just like with Microsoft in the early 1990s, it will make you look very silly in retrospect. You’re being bet by better DNA baked into a much more diverse and adaptable product line from many industry players.

Bryan Chaffin

The basic problem with Apple is lack of fragmentation.

That’s only if you define “winning” as “having the most market share.”

As I have explained many times, market share matters to Google, while hardware profits matter to Apple.

All that fragmentation is certainly a part of having the biggest share of the market, but it also results in less happy customers, frustration for developers, and a bunch of OEMs duking it out for the bottom end of the market.  Google wins, while most OEMs struggle (Samsung being the exception).

In the meanwhile, Apple takes between 70-80% of all the industry’s hardware profits and makes money hand over fist.

This is not a problem for Apple, it’s a license to print money.

Google and Apple are not playing the same game and both can be winners.

Bryan Chaffin

And BTW, this ?you copy us? crap may make you all feel superior now, but just like with Microsoft in the early 1990s, it will make you look very silly in retrospect. You?re being bet by better DNA baked into a much more diverse and adaptable product line from many industry players.

Care to make a bet? You’ve been making these “better DNA/diverse is awesome” argument for years now, Brad, and yet Apple still keeps kicking butt.

Bosco (Brad Hutchings)

Bryan, The most surprising part for me about Apple’s results were how dependent Apple is on the iPhone for its revenues and profits. Cook’s mistaken analysis is that he thinks Apple lost customers to the future iPhone, when Apple actually lost customers to choice and better phones. Apple has no way to respond the trends in the market as quickly as the Android handset makers, so in the year plus between iPhone revisions, the market goes off and does something completely unexpected that customers love (e.g. 5” handsets with styluses!!) and Apple can’t even react until a year later. And even if Apple were to react, it just ends up shipping a larger phone with crappier resolution because it hasn’t embraced any fragmentation.

Apple still has a good lead in tablets, but the same things will play out. To reach 7”, Apple will use 1024x768 because that’s all it knows and all its developers account for. Meanwhile Google/ASUS exceed what we imagine Apple might do in small form factor because the Nexus 7 is at 1280x800 already.

Basically, there’s a limit to how far one company can go it alone in this industry rather than cooperate, and we’re pretty much at it. Just like with Windows vs. Mac in the early 1990s, customers will go where the value is, and that’s just not in Apple’s corner any longer in mobile.

Bryan Chaffin

I still maintain that the iPad market will be like the iPod market, not the smartphone market. So far, I’ve been proven prescient and correct.

You are certainly correct that Android’s open licensing model allows OEMs to be more flexible, and I think they have capitalized it on it wonderfully well. That is, in fact, a benefit of open licensing.

But none of that negates what I said. Apple still takes all the hardware profits, has the largest ecosystem, and the happiest customers who pay the most for apps, download the most apps, use their devices the most, etc.

You seem to want to insist that Apple must lose for Android to win.

That’s not the case. It won’t be the case.

Google can win while Apple wins. One Android OEM can win, too, and that’s Samsung for the nonce, but Apple will still take most of the hardware profits.

It’s all a big apples to oranges comparison.

But if you want to quantify your predictions (again), I’ll wager with you.

geoduck

This sums up my personal opinion of the market.
Non Sequetor July 26

Wall Street is very efficient,

Efficient in the way a group of small animals that spook at this or that are ‘efficient’.

The Street as a whole is a very rational entity,

People are rational creatures in the same way the ocean is a body of salt. In reality people are mostly emotions, with a small percentage of rational behavior. What’s more they use what logic they have as a justification for emotional responses. So no I don’t see The Street as rational. If it were, short term greed would lose out to long term planning.

skipaq

While the back and forth on iOS vs. Android is a rehash of the same old (3 years and counting) arguments; the point of this article was to explain the sell off in share price on AAPL.

I have been reading and following this stock for nearly 30 years. I have been invested in it since the late 1990’s (that is right; before iAnything came along.) I used to do my buying and selling around MacWorld events. The reason was simple. The price direction before and after this event could fairly accurately be predicted. This enabled increasing the number of shares owned.

Obviously this is no longer possible. Finding another method has been a challenge. One of these of course is related to the quarterly reporting. But this has not proven as consistent. I have seen reports where Apple absolutely blew the analysts predictions and consensus to so much confetti. Low and behold the share price doesn’t move or it goes down.

This may be rationalized by Wall Street minds; but it is anything but rational. Is Apple’s balance sheet better today than before? Did Apple meet or beat their own guidance? Is Apple worth less today? Was their performance better than most tech or any stocks? These have little to do with Wall Street’s reaction.

So just what is their logic? Apple didn’t meet our consensus on iPhone sales and earnings per share; so let’s drive the price down. And this they can do because of the power of large numbers. And that is the reason for the down. MacWorld used to provide a way to predict the mood of this crowd and thus what they would do. In fact, there used to be a familiar investment saying surrounding this event.

Bryan, I suggest this has much to do with Apple’s noted secrecy and played a roll in Steve’s desire to get out of that cycle. I also think that you have exaggerated Apple’s penchant for “sandbagging its guidance for the past 12 years or so.” Did Apple really know how well the iPod would sell before they released it? Or the iPhone? Or the iPad?

Yes, they have been ultra conservative at times. Perhaps they now have a handle on things; at least t’ill the next great thing comes to light. OK. Brad, you can go back riding your hobby that has little to do with this discussion.

llg4nlp

So just what is their logic? Apple didn?t meet our consensus on iPhone sales and earnings per share; so let?s drive the price down. And this they can do because of the power of large numbers.

Having watched the overall market for a couple of decades now, I don’t think there is a single logic. I think of it in a similar way that I might troubleshoot a Mac.  It could be the hardware - a loose RAM chip?, or perhaps the OS - new install of Mountain Lion?, or perhaps the app I’m working with.  Possibly all of the above?

Analogously, the macro economic environment could be the issue, or perhaps the tech sector as a whole - how did MSFT, Intel, etc. do?  Sometimes investors extrapolate in ways that don’t make sense, i.e. I’ve seen them sell of AAPL, when DELL had a poor earnings report, on the theory that sales of PCs are down, so it must extend to all hardware vendors. (For example.) Or it could actually be something in Apple’s guidance, the earnings report, the conference call, etc.

In this specific case, I think the macro economic environment is playing a huge role.  The belief is that, since Europe is in recession, China’s growth is slowing, and the US economy is barely inching forward, lots of folks won’t spend money on iPhones, iPads, etc.  So the thinking goes.

Everyone, of course, has to decide upon their own investment strategy.  Personally, though, I pay a lot of attention to P/E ratios, and so, for instance would never buy AMZN.  I realize lots of people are making money with that stock - but, not for me, IMO, too much risk.

OTOH, I have no problem with a ‘Buy & Hold’ strategy w/respect to AAPL, especially now that they are paying a dividend.  YMMV

vpndev

The part that doesn’t seem to me to be “rational” is that the price has so quickly recovered from about $570 to $610 (today’s close).

If it were rational to decline 6% when the report was released, what has changed?

If nothing has changed, where’s the rationality?

Bryan Chaffin

New value is being put back into the stock based on the AuthenTec purchase, plus, value is being reassigned to Apple based on Strategy Analytic’s U.S. market share story from Monday.

Indeed, that story essentially means that the market got it at least partially wrong when it pushed AAPL down for missing iPhone estimates. Being rational doesn’t always mean being right.

The market is also assigning new value to Apple’s September quarter based on the September 12th media event. The timing suggests that Apple’s September quarter might be better than anticipated based on Apple’s sandbagging guidance.

Lastly, new value is also being assigned to Apple based on *slightly* decreasing economic worries (this ebbs and flows in a constant shift).

skipaq

Bryan, thanks for the explanation. I do feel that this quick turnaround illustrates how much the market is driven by speculation. The AuthenTec purchase leads to mobile payment speculation which would add value to Apple’s mobile products. But that is speculative value until it is actually delivered and drives sales.

The September 12th media event is also speculative. While we do almost know that Apple will be unveiling the latest iPhone near that timeframe; the speculation is on what else (iPad mini?) is introduced. This brings me to what often used to happen with Apple’s stock: Buy the rumor and sell the news. This doesn’t always hold true now; as even in the past it didn’t.

But I believe it plays a part in what happens with Apple’s financials at times. The analysts put up their numbers (often inflated numbers) and the stock is bought on this speculation. If the report disappoints (sometimes in one item as in iPod days) the stock gets sold on the news.

The value that they are adding in is speculative. I am not saying this is irrational; but it doesn’t always make sense to the average investor. Of course the market is speculative at its’ heart. wink

Lee Dronick

Do the high rollers make decisions themselves, a real person, or is an app making the decision? I am not being a wiseguy, it just seems that if you overlap graphs from several tech stocks they look to have the same contour. This leads to me think that it is some sort of AI making decisions.

llg4nlp

This leads to me think that it is some sort of AI making decisions.

Probably some of both - programmed trading is a reality, but so are hedge fund managers, as well as money managers who invest for such entities as Pension Funds. 
That said, often the reason tech stocks show the same contour in their respective charts is that many investors of these sorts invest in the tech sector as a whole (i.e. ETFs), and/or the market, as a whole is going up and down in response to global economic factors.

Lee Dronick

Thanks

Lee Dronick

Did you hear about the stock trading software glitch today

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